counteroffers for prices under various pricing terms, each time failing to reach agreement. Finally, in December 1961 after construction of the ship was approximately 75 percent complete, agreement was reached between the Bureau of Ships and Bethlehem on a firm fixed price of $87 million.

The contract approval authority, which was within the Office of Naval Material, considered the price too high based upon its review of cost data, cost estimates and other accumulated data and recommended against acceptance of the firm fixed price of $87 million. That Office in turn recommended a cost-plus-incentivefee contract with a target cost of about $80.5 million and incorporating approximately a 7-percent fee. Under this type of contract the payment to the contractor would be based primarily upon the cost actually incurred. Bethlehem refused to accept any terms other than a fixed price of $87 million.

After disapproval by the Office of Naval Material of Bethlehem's offer of $87 million, the matter was referred to the Assistant Secretary of the Navy. The Assistant Secretary verbally approved the price offer on January 11, 1962, and the letter contract was converted to a definitive contract on the same date.

Our analysis of Bethlehem's statement of cost incurred and estimated costs to complete the ship, submitted in support of the $87 million price, disclosed that it contained contingencies, overhead, and other costs not properly chargeable to the contract amounting to over $5 million. It is our view that conversion to a fixed price at a point in time when the contract was 75 percent complete relieved the contractor of a substantial part of the normal risks of performing a firm fixed-price contract. Further, Bethlehem, by its insistence on a firm fixed price which contained contingencies and overcharges amounting to a little over $5 million, was taking unfair advantage of the Government in insisting on these terms.

We concluded in this case that the Navy paid Bethlehem more for this ship than was warranted on the basis of available cost data and the circumstances existing at the time of negotiations and that the Navy should seek a price adjustment.

Further, we believe the conditions noted during our review support the Assistant Secretary of Defense's criteria for seeking a price adjustment from Bethlehem inasmuch as:

(1) Our review established that contract price included unwarranted charges for contingencies, overhead, and other costs and the Navy determined, after the contract award, that improper costs were included in the contract price, and

(2) The retention by the contractor of the amount in question would, in our opinion, be contrary to good conscience and equity.

In this connection, the Navy unsuccessfully attempted to obtain a voluntary refund from Bethlehem. Some of the details involving the basis for seeking this refund are as follows:

In August 1960, we had started a review of Bethlehem's overhead costs charged to Navy contracts. Our review disclosed that improper overhead costs totaling about $2.4 million were being charged to Navy cost-type contracts. The improper costs involved charges which should have been allocated to either Bethlehem's commercial contracts or Government fixed-price contracts. The improper method of allocating costs would tend to give Bethlehem an advantage in competing for commercial or fixed-price Government business at the expense of Government cost reimbursable contracts.

After our findings had been brought to the Navy's attention in August 1961, they initiated a special study of Bethlehem's accounting system and cost allocation practices. At the conclusion of its study, the Navy disallowed costs of $4,805,000 against certain cost-type contracts. In addition, the Navy concluded that costs of $1.3 million allocated to the Bainbridge contract prior to conversion to a fixed-price contract would have been questioned if that contract had continued as cost type.

On March 29, 1963, the Assistant Secretary of the Navy in a letter to the vice president of Bethlehem's shipbuilding division, noted that at the time an agreement was reached on the price to be paid for the Bainbridge, there was some question regarding the allocation of costs to the Bainbridge. The Assistant Secretary further pointed out that it was understood that he Navy would expect to receive further consideration of this matter in event the amount was significant. More complete information developed by the Navy disclosed that the amount involved approximately $1.3 million. Therefore, the Assistant Secretary requested

48-132-65-12

a meeting to work out the refund due the Navy in accordance with the above understanding.

Bethlehem did not reply to this request and the Assistant Secretary of the Navy again, in a letter dated September 20, 1963, requested a meeting. We have been advised that such a meeting was held on October 15, 1963, and Bethlehem refused to agree to the price adjustment requested by the Navy.

In connection with our report on another case, B-140757, dated January 15, 1963, the Assistant Secretary of Defense stated the Department's position that no request for voluntary refund was in order, though agreeing with us that the contractor was wrong in adopting a take-it-or-leave-it position. He stated that this was another "eyes open" situation.

This case involves catalog prices charged for Klystron tubes under noncompetitive procurements negotiated by the military departments and their prime contractors with Varian Associates, Palo Alto, Calif. In sole-source procurements totaling over $5 million, Varian quoted prices from its catalog and refused to furnish supporting cost data or to negotiate prices. The prices which Varian unilaterally established on the Government orders we examined exceeded the company's prior cost of production by from 23 to 231 percent. Further, the prices for the tubes exceeded actual production costs of the orders we examined by from 36 to 279 percent.

Two Varian brothers invented the first workable Klystron tube. Since the incorporation of Varian in 1948, the Government has awarded approximately $16 million to Varian in both prime contracts and subcontracts of the cost-plusa-fixed-fee type for research and development on Klystron products. In addition, approximately $3.5 million was awarded for research and development work in the tube division on other types of tubes, and approximately $9 million was awarded for product research in other divisions. Also, considerable additional research and development were carried out by Varian and the costs were borne by the Government, both through direct charges and overhead allocations to production contracts and subcontracts in all divisions.

On the klystron tubes we reviewed, Varian informed the Government or prime contractors that the items were proprietary or catalog items and that it was their policy to refuse experienced cost details to the Government or its prime contractors. Of the types of klystron tubes we reviewed practically all sales were made to the Government or to contractors for use in fulfilling Government contracts. Where the Government is practically the sole customer for the product and where the Government has made such substantial contributions toward the development of klystron tubes, we think it is inappropriate to designate such items as proprietary for the purpose of establishing prices on Government procurement and thereby avoiding the submission of essential cost and pricing data and price negotiations. Accordingly, we recommended that the Department of Defense seek price adjustments for the procurements in question. Public Law 87-653 now requires submission of cost and pricing data in situations of this kind.

Also, it should be pointed out that one of the purchase orders discussed in our report which was issued by a prime contractor, the General Electric Co., contained a provision to the effect that the price is subject to satisfying the General Accounting Office that the price is fair and reasonable. Concerning this purchase order, the Air Force, after consultation with our office, endeavored to make a settlement with Varian Associates. The result of this effort was a price adjustment of $225,000 on a purchase order for $863,915.

Our report, B-146892, dated August 28, 1964, involves a case where Pratt & Whitney Aircraft Division, United Aircraft Corp., during the 9-year period 1951 through 1959, used Government-owned facilities without the payment of rent in the production of about 10,000 piston engines which it sold to commercial customers.

Under the original facilities contract, executed in September 1950, Pratt & Whitney was granted rent-free use of Government-owned facilities under the condition that any benefits its commercial engine production realized from use of these facilities would be reflected in the prices paid by the Government for military engines. Pratt & Whitney's commercial engine production did benefit from the use of these facilities. However, we could find no evidence of benefits accruing to the Government. Subsequent to our initial inquiries into this matter, Pratt & Whitney agreed to pay rent of $819,000 for use of the Government facilities in commercial piston engine production during 1960, 1961, and 1962.

The record of negotiation of prices paid by the Government for military engines did not identify any allowances made to the Government in recognition of the benefits to commercial piston engines from use of these facilities during the period 1951 through 1959. It was therefore our view that such commercial use under these conditions during this period was not only inequitable to the Government but resulted in Pratt & Whitney's receiving economic benefits not generally available to other manufacturers. Accordingly, we recommended that the Secretary of the Navy collect a reasonable rental from Pratt & Whitney for its use of Government-owned facilities in commercial piston engine production during the years 1951 through 1959.

Our report, B-146886 dated May 21, 1964, covers our review of employee relocation costs charged to the Government under defense and space contracts held by the Lockheed Missiles & Space Co., Sunnyvale, Calif. We disclosed that unnecessary costs during a 12-month period, totaled $101,200. These excessive payments were caused by Lockheed's practice of paying employees transferred from one location to another a daily relocation allowance for a period greatly in excess of the period actually needed to establish a new residence. We found that under Lockheed's policy, employees received daily relocation allowances for a full 30-day period without regard to the actual number of days required to relocate. Lockheed's Government contracts are about 99 percent cost-reimbursement type and we did not recommend a voluntary refund as indicated by the Assistant Secretary of Defense. Our recommendation, in effect, was that contracting officers review their actions in approving the reasonableness of the relocation expenses for reimbursement and to disallow any amounts found to be unreasonable.

After we presented our findings to the company, Lockheed revised its relocation policy to limit such per diem payments to the actual number of days require to establish residence. Also, we were advised by the Department of Defense in February 1965 that $99,000 had been disallowed in negotiation of 1962 overhead at the Sunnyvale plant. The Department earlier advised us that it had decided not to reopen past negotiations, for to do so would require reopening other elements of overhead which the Department felt had been settled generally in the Government's favor. Since this general statement does not disclose the types or amounts of expense the agency anticipates the contractor would claim, we may, if time and circumstances permit, review prior year's settlements of overhead for the purpose of evaluating the basis for this decision.

Another report the Assistant Secretary of Defense discussed in his statement is B-146901, dated August 24, 1964.

In this report we disclosed that the Army purchased from the Raytheon Co. about $1.1 million worth of spare parts for Hawk missile field maintenance test equipment which were unneeded because the test equipment had been replaced. Under a cost-reimbursable contract Raytheon had undertaken broad responsibilities for the development and production of the Hawk missile system, including the requirement to furnish the Army with spare parts lists for this system. The unnecessary procurement was a result of Raytheon's submission to the Army of superseded spare parts lists. This was done with the knowledge that the items on the lists were for nontactical equipment that had been superseded by new tactical equipment already on quantity procurement. Raytheon also knew that the spare parts lists submitted would be used by the Army for the purposes of determining procurement needs. Furthermore, Raytheon failed to question the validity of the Army's orders in quantity even though it had knowledge that the parts had been superseded and that the orders were placed on spare parts lists which were outdated.

The Assistant Secretary of Defense, in his testimony before this subcommittee, stated that the procurement of the unneeded spare parts was not a result of any failure on the part of the contractor, as contended in our report, but was due instead to the action of the Government in accelerating deliveries, thereby disrupting the orderly process of spare parts provisioning.

We do not believe this to be a valid reason for relieving Raytheon because Raytheon had agreed to provide the required information for spare parts procurements by means of major item repair parts lists. Raytheon had been well aware that the field maintenance test equipment had undergone a major design change. Raytheon had a liaison engineer at the subcontractor's plant, whose express duties were to review and monitor repair parts documentation, and Raytheon had been recently advised by the Missile Command that it was late in submitting documentation. Nevertheless, at about the same time that production of new

redesigned tactical equipment was initiated, Raytheon prepared major item repair parts lists which erroneously indicated to the Missile Command that the nontactical assemblies were repair parts for the tactical equipment. It is our belief that Raytheon did not properly discharge its obligation to the Government when it did not question the validity of the unnecessary procurement when the orders were received. We consider the charges for these unnecessary procurements to be unreasonable under the applicable contracts and, therefore, requested the Secretary of Defense to withhold $1 million from payments due Raytheon. However, as you know, the Department of Defense has declined to do so.

The Assistant Secretary of Defense also expressed disagreement with our finding that the Lane Construction Corp. contract was illegal. Our position on this case, we believe, was adequately discussed in our testimony on May 11, 1965.

PRICING POLICY

The Assistant Secretary of Defense indicated that there was a difference between our views and those of the Department of Defense on pricing policy. He characterized the disagreement as primarily a difference between the costtype approach to defense contracting and the fixed-price approach. He stated that our office has tended to criticize the use of fixed-price contracts when uncertainties or risks have been involved.

First, let me say that the public record is replete with evidence that we support the Assistant Secretary's concern for the inherent lack of incentives for reducing costs under cost-type contracts. There should be no question of our position on that point. It is also public knowledge that we have consistently supported legislation designed to promote increased use of formally advertised fixed-price contracts.

However, our criticisms have been directed at those instances where the allowance of substantial provisions for contingencies or other conditions have relieved the contractor of much of the risk factor that encourages economical performance. As we have stated in the Bainbridge case it is our opinion that the Navy was not compelled to accept an excessive price in order to obtain a definitive contract. The extra motivation for efficiency and economy which fixed-price contracting normally provides was greatly diminished in this case because three-quarters of the work had already been completed on a cost-reimbursable basis. We believe the Navy overvalued the advantages of fixed-price contracting in this case when it accepted a price which included provisions for contingencies of about $3.4 million and duplications and overstatements of costs of about $1.6 million. Had further negotiations been unsuccessful the ship could have been completed under the terms of the letter contract and the price and other terms could have been settled on a quantum meriut basis; that is, the Government would only pay the reasonable value of the services performed.

The Assistant Secretary of Defense also states that we have criticized the Department of Defense in certain cases in which cost-type contracts were converted, during the course of performance, to fixed-price contracts. He stated that in these cases we have expressed concern that the contractor earned a profit considered by us to be excessive because actual costs turned out to be lower than anticipated. The testimony does not identify the cases to which the Assistant Secretary refers; however, we believe one case in point to be our report on the Spanish base construction program, B-118763, dated December 30, 1960. In this case, the Navy converted a contract with Brown-Raymond-Walsh (a joint venture) from a cost-plus-a-fixed-fee basis to a fixed-price basis on certain portions of the contract. Our review disclosed that this action may have added as much as $9.4 million to the cost to complete the Spanish base construction program without providing any material increase in the scope of the contractor's services. The fixed price established to complete the program included administrative costs that were about $6.7 million in excess of a reasonable amount to be incurred based on the contractor's prior cost experience under the cost-plus-afixed-fee portion of the contract. Also, the price included a profit and contingency allowance to the contractor which was about $2.6 million in excess of the fee the Government would have borne had the contract been completed on a cost-plus-a-fixed-fee basis.

This report was the subject of hearings before the Subcommittee for Special Investigations, Committee on Armed Services, House of Representatives. On April 28, 1961, a Navy official informed the subcommittee that, by placing additional work under the contract with little or no allowance for the contractor's

related administrative costs as of April 1, 1961, the Navy had recovered $5.1 million of the excess cost allowance reported by us. He further stated that negotiations would be studied with the contractor to insure full recovery prior to contract closing.

In a followup review, we found that the Navy had erred in its computations. Actual recovery resulting from placing additional work under the contract amounted to only about $3 million. In reply to our followup review, the Department of Defense advised that further action by the Department would be inappropriate and stated that the contractor will receive special separate attention by the Renegotiation Board.

We believe our positions in these cases are sound.

GOVERNMENT INVOLVEMENT IN THE INTERNAL AFFAIRS OF DEFENSE CONTRACTORS The Assistant Secretary of Defense referred to a series of reports in which the General Accounting Office had criticized the Department of Defense for indirect procurement of components and assemblies. We had stated that unnecessary costs have been incurred because the military departments permitted weapons systems contractors to purchase equipment, components, and accessories under circumstances where, in our opinion, it would have been more economical for the Government to purchase the item directly from the manufacturers and furnish them to the prime contractors as Government-furnished equipment. One of our reports in this series was a report issued in December 1964, wherein we disclosed evidence that higher costs of about $4.1 million had been incurred in the procurement by the Navy of aircraft because certain components had been purchased by the airframe manufacturer rather than furnished by the Government. One of the components was a horizontal situation indicator system, an item common to both Navy and Air Force aircraft. We found that whereas the Air Force found it feasible and economical to purchase these systems direct from the manufacturer and furnish them to the airframe manufacturers for installation in the aircraft, the Navy considered it necessary that the systems for its aircraft be purchased by the airframe manufacturers. The Government incurred estimated increased costs of about $1.2 million with respect to the indicator systems for Navy aircraft. After the results of our review were brought to the Navy's attention, they acknowledged to the House Appropriations Committee that they were remiss in not providing this item as Government-furnished equipment earlier. We were further advised by the Navy that arrangements had been made with the Air Force to consolidate Navy procurement needs with Air Force procurements for the horizontal situation indicator system and to furnish this system to applicable Navy airframe manufacturers as Government-furnished equipment in fiscal year 1965.

In another report, issued in December 1963, we reported on a situation where the Air Force required certain electronic equipment for modification of aircraft to be procured by the contractor. We found that the Navy was procuring identical items of electronic equipment directly from equipment suppliers to meet their requirements. Had the Air Force purchased on the same basis, the Government should have avoided increased costs of about $1.1 million.

The Assistant Secretary of Defense also included in his testimony certain comments on the contents of a draft report of the General Accounting Office which had been furnished to the Department to obtain its views before completing our report. Those views have not been furnished to us to date and the report has not been released. He stated that we had recommended in this report that the Department of Defense adopt a general policy under which it would furnish to prime contractors all subsystems and components except where the prime contractor makes a major contribution to the production of the item or in providing technical assistance to the contractor.

One important point which the Assistant Secretary of Defense omitted should be called to your attention. The primary theme of this draft report which was submitted to the Department of Defense on March 11, 1965, was the lack of definitive policy on furnishing subsystems to prime contractors with the result that higher costs are incurred.

We pointed out that the general policy provided in the Armed Services Procurement Regulation gives broad latitude to the military departments and there appears to be a wide variance among the military departments and commands in the implementation of the general policy enunciated by the Department of Defense. For example, the Air Force in its policy directives has taken the position that its responsibility as a system acquisition manager cannot be contracted